Equity Release Working Party. Pricing & Risk Capital In the Equity Release Market 27 March 2008

Transcription

1 Equity Release Working Party Pricing & Risk Capital In the Equity Release Market 27 March 2008

2 Who are we? Ged Hosty (Chair) - In Retirement Services Steve Groves - Partnership Assurance Colin Murray - Watson Wyatt Mikir Shah - FPK

3 Agenda Introduction Types of product Assumptions Modelling House Price Inflation Cost of Funds Expenses Cost of No Negative Equity Guarantee Results Summary

4 Health Warning All work based on sample products Results could change significantly with change in assumptions/product types Product providers need to examine their own business carefully and generate their own assumptions

5 Introduction 9.00% 8.50% 8.00% 7.50% 7.00% Rate (%) 6.50% 6.00% 5.50% 5.00% 4.50% 4.00% Apr-99 Oct-99 Apr-00 Oct-00 Apr-01 Oct-01 Apr-02 Oct-02 Apr-03 Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Top 3 Competitors - Average customer rate Trendline (Average of Top 3 Customer Rates) 20 Year Sw ap Trendline (20 Year Sw ap Rate)

6 Product Types Lifetime Mortgages Lump sums Drawdown Fixed rate/variable rate Protected equity Higher LTVs/Interest rates Fixed Repayments

7 Product Types Reversions Cash Income Stepped Impaired lives

8 Interesting Risks Mortality LTC Early Redemption HPI

9 Mortality Little experience No reinventing the wheel Heavily dependent on factors such as sales channel, marketing, product features Used PNXA (U=2007) (with early selection) Adjusted for social class Improvements at P-Sac

10 Long Term Care No further data over the last 2 years. Assumptions unchanged from last ERWP report. Males addition of 2% to 5% to mortality Females addition 3% to 13% to mortality

11 Early redemptions Little experience (Norwich Union) Some are LTCs in disguise Flat redemption charges are one way bet on interest rates Need to consider Redemption charge scale Prevailing interest rate Distribution channel Product design Competitive positioning Assumed rates 1%-2% in years 1 to 2 Rising to 2.5% in years 4-5 Reducing to 0.5% by year % by year 20

12 House price inflation Reviewed OECD data (min/max long term) Analysed UK data Regional data Autocorrelations Desmoothed Derived range assumptions for pricing Not predicting house prices!

13 OECD Data 5 Real House Price Growth (1970=1) US Japan Germany France UK Ireland Italy Canada Spain Australia Netherlands Belgiums Sweden Switzerland Denmark Norway Finland

14 OECD Data 2.5 GDP deflated HPI (1970=1) US Japan Germany France UK Ireland Italy Canada Spain Australia Netherlands Belgiums Sweden Switzerland Denmark Norway Finland

15 UK Property Average annual HPI since 1974 just under 9% p.a. Max 9.3% p.a. in London, min 8.3% p.a. Scotland Volatility of 5% p.a. Autocorrelation (1 step) 0.66 Desmoothing (1 step) volatility of 11% per annum.

16 Assumption Min = OECD data = CPI? Max = RPI (2.5%) + Economic Growth (2.5%) = 5% p.a. How much desmoothing is appropriate? Assumed 4.5% HPI and 8% volatility (plus 3% for binary risk)

17 Cost of Funds Expected redemption profile Insurance provides cover for cost of breaking swaps / securing new swaps as required provided redemption profile remains within tramlines Portfolio Run-Off 0 Time

18 Cost of Funds Cost of funds based on cost of swaps for the redemption profile Extra margin above swaps for insurance Base cost of funds given by: Average swap rate weighted by cashflows Funders margin over LIBOR Margin to cover risks Providers cost of hedging for residual risks No negative equity guarantee Margin over LIBOR assumed to be 40bps plus 25 bps for tramline insurance

19 Cost of Solvency Capital FSA capital requirement is 8% of mortgage outstanding plus additional drawdown Weighting of 35% if projected mortgage amount is less than 80% of house value Cost of capital assumed to be 2% p.a. Annual cost 7 bps

20 Expenses Heading Distribution Marketing Administration Expense inflation Other costs Amount 2.5% of advance 1.0% of advance 500 initial 60 p.a. renewal 350 termination 3% p.a. Passed to customer (e.g. valuation)

21 NNEG Cost Using option pricing methodology Two approaches Quasi market consistent/risk neutral Real world

22 NNEG Cost Quasi market consistent Risk free rate of 4.75% p.a. Current rental yield of 3.3% p.a. (net) Forward HPI rate of 1.5% p.a. Volatility of 11% p.a.

23 Quasi Market Consistent Sample case Option price as a percentage of initial mortgage Option price as an annual percentage of the outstanding mortgage Male 65 18% 0.73% Female 65 19% 0.74% Joint life 65 29% 0.90% Male 70 12% 0.64% Female 70 13% 0.67% Joint life 70 20% 0.82% Sample Portfolio 15% 0.67%

24 Sensitivities 0% forward rate Sample case Option price as a percentage of initial mortgage Option price as an annual percentage of the outstanding mortgage Male 65 29% 1.22% Female 65 31% 1.24% Joint life 65 45% 1.45% Male 70 20% 1.09% Female 70 22% 1.13% Joint life 70 32% 1.34% Sample Portfolio 25% 1.11%

25 Sensitivities - Volatility Sample case Volatility of 14% Volatility of 17% Male % (0.9% p.a.) 24.1% (1.0% p.a.) Female % (0.9% p.a.) 25.9% (1.0% p.a.) Joint life % (1.0% p.a.) 36.2% (1.1% p.a.) Male % (0.8% p.a.) 17.1% (1.0% p.a.) Female % (0.8% p.a.) 19.2% (1.0% p.a.) Joint life % (1.0% p.a.) 27.3% (1.1% p.a.)

26 Real world pricing Stochastic model Log normal distribution HPI at 4.5% p.a. Volatility of 11% p.a.

27 Real world results Sample case Option price as a percentage of initial mortgage Option price as an annual percentage of the outstanding mortgage Male % 0.10% p.a. Female % 0.10% p.a. Joint life % 0.13% p.a. Male % 0.10% p.a. Female % 0.10% p.a. Joint life % 0.13% p.a. Sample Portfolio 2.7% 0.12% p.a.

28 Results Heading Average swap rate Funder s margin Tramline insurance Cost of solvency Cost of NNEG (?) Expenses Profit (?) Cost to Borrower Amount 5.10% 0.40% 0.25% 0.07% 0.12% 0.30% 0.45% 6.70%

29 Summary Margins getting tighter but little experience to go on. A lot of risks unknown (e.g. mortality, redemptions etc.) Pricing basis needs to be tailored to individual company and product features Possible that profits are being made If NNEG on a market consistent basis, unlikely to be profits!